AIG 2007 Annual Report Download - page 72

American International Group, Inc. and Subsidiaries
In the event of a downgrade of AIG, AIG would be required to the extent not mitigated by collateral or other credit enhance-
post additional collateral. It is estimated that, as of the close of ments. A reinsurer’s insolvency or inability or refusal to make
business on February 14, 2008, based on AIG’s outstanding timely payments under the terms of its agreements with the AIG
municipal GIAs and financial derivatives transactions as of such subsidiaries could have a material adverse effect on AIG’s results
date, a further downgrade of AIG’s long-term senior debt ratings of operations and liquidity. See also Management’s Discussion
to Aa3 by Moody’s or AA- by S&P would permit counterparties to and Analysis of Financial Condition and Results of Operations —
call for approximately $1.39 billion of additional collateral. Risk Management — Reinsurance.
Further, additional downgrades could result in requirements for
substantial additional collateral, which could have a material Adjustments to Life Insurance & Retirement
effect on how AIG manages its liquidity. For a further discussion Services Deferred Policy
of AIG’s credit ratings and the potential effect of posting collateral Acquisition Costs
on AIG’s liquidity, see Management’s Discussion and Analysis of Interest rate fluctuations and other events may require AIG
Financial Condition and Results of Operations — Capital Re- subsidiaries to accelerate the amortization of deferred policy
sources and Liquidity — Credit Ratings and — Liquidity. acquisition costs (DAC) which could adversely affect AIG’s
consolidated financial condition or results of operations. DAC
Catastrophe Exposures represents the costs that vary with and are related primarily to
The occurrence of catastrophic events could adversely affect the acquisition of new and renewal insurance and annuity
AIG’s consolidated financial condition or results of operations. contracts. When interest rates rise, policy loans and surrenders
The occurrence of events such as hurricanes, earthquakes, and withdrawals of life insurance policies and annuity contracts
pandemic disease, acts of terrorism and other catastrophes could may increase as policyholders seek to buy products with perceived
adversely affect AIG’s consolidated financial condition or results of higher returns, requiring AIG subsidiaries to accelerate the
operations, including by exposing AIG’s businesses to the amortization of DAC. To the extent such amortization exceeds
following: surrender or other charges earned upon surrender and withdraw-
)widespread claim costs associated with property, workers als of certain life insurance policies and annuity contracts, AIG’s
compensation, mortality and morbidity claims; results of operations could be negatively affected.
)loss resulting from the value of invested assets declining to DAC for both insurance-oriented and investment-oriented prod-
below the amount required to meet the policy and contract ucts as well as retirement services products is reviewed for
liabilities; and recoverability, which involves estimating the future profitability of
)loss resulting from actual policy experience emerging ad- current business. This review involves significant management
versely in comparison to the assumptions made in the judgment. If the actual emergence of future profitability were to be
product pricing related to mortality, morbidity, termination substantially lower than estimated, AIG could be required to
and expenses. accelerate its DAC amortization and such acceleration could
adversely affect AIG’s results of operations. See also Manage-
ment’s Discussion and Analysis of Financial Condition and Results
Reinsurance
of Operations — Critical Accounting Estimates and Notes 1 and 6
Reinsurance may not be available or affordable. AIG subsidiaries to Consolidated Financial Statements.
are major purchasers of reinsurance and utilize reinsurance as
part of AIG’s overall risk management strategy. Reinsurance is an Use of Estimates
important risk management tool to manage transaction and
insurance line risk retention, and to mitigate losses that may arise If actual experience differs from management’s estimates used
from catastrophes. Market conditions beyond AIG’s control deter- in the preparation of financial statements, AIG’s consolidated
mine the availability and cost of the reinsurance purchased by AIG results of operations or financial condition could be adversely
subsidiaries. For example, reinsurance may be more difficult to affected. The preparation of financial statements in conformity
obtain after a year with a large number of major catastrophes. with accounting principles generally accepted in the United States
Accordingly, AIG may be forced to incur additional expenses for requires the application of accounting policies that often involve a
reinsurance or may be unable to obtain sufficient reinsurance on significant degree of judgment. AIG considers that its accounting
acceptable terms, in which case AIG would have to accept an policies that are most dependent on the application of estimates
increase in exposure risk, reduce the amount of business written and assumptions, and therefore viewed as critical accounting
by its subsidiaries or seek alternatives. estimates, are those described in Management’s Discussion and
Analysis of Financial Condition and Results of Operations —
Reinsurance subjects AIG to the credit risk of its reinsurers and Critical Accounting Estimates. These accounting estimates require
may not be adequate to protect AIG against losses. Although the use of assumptions, some of which are highly uncertain at
reinsurance makes the reinsurer liable to the AIG subsidiary to the time of estimation. For example, recent market volatility and
the extent the risk is ceded subject to the terms and conditions of declines in liquidity have made it more difficult to value certain of
the reinsurance contracts in place, it does not relieve the AIG AIG’s invested assets and the obligations and collateral relating to
subsidiary of the primary liability to its policyholders. Accordingly, certain financial instruments issued or held by AIG, such as
AIG bears credit risk with respect to its subsidiaries’ reinsurers to
18 AIG 2007 Form 10-K